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Audit Eye on Exec Pay

Accounting regulators want auditors to look more closely at compensation agreements as a source of risk.

Is a proposed audit standard on related-party transactions from the Public Company Accounting Oversight Board (PCAOB) mission creep, or just a pointed reminder to auditors to pay attention to the potentially corrupting role of executive compensation arrangements? In putting forward the new standard in February, the board noted studies showing that one-quarter of its disciplinary actions cite auditor failure with respect to related-party issues, including significant unusual transac tions, and that 90% of fraudulent financial reporting cases brought by the Securities and Exchange Commission involve top executives. The proposed standard requires auditors to look for ways pay agreements might lead to excessive risk-taking or actions designed to benefit an executive at the expense of shareholders.

“This proposal would amend existing standards to require auditors to perform procedures to obtain an understanding of the company’s financial relationships with its executive officers,” Steven Harris, a member of the PCAOB, said in a meeting.

The change is likely to mean auditors would have to carefully read those portions of proxies related to compensation, as well as the agreements themselves, adding to the audit firm’s billable hours and the cost of an audit.

The proposal met with resistance from the U.S. Chamber of Commerce. “The PCAOB is clearly crossing a threshold into corporate governance, and we feel they don’t have the jurisdiction to go there,” says Tom Quaadman, vice president of the Chamber’s capital markets center, who testified against the proposal at a March congressional hearing.

Quaadman calls the proposal “mission creep” and says it’s “part of a systematic move by the PCAOB to overstep its role” and “assert its authority over executive compensation.”

Greg Scates, deputy chief auditor at the PCAOB, disputes this. “The chamber is painting a false picture that the auditors will be giving an opinion on compensation,” Scates says. “That’s wrong. That’s the role of the compensation committee. We’re just saying to auditors, ‘Look at the incentives in the compensation. See if they pose a risk.’ They need to document what those risks are.

“We don’t think this is a significant undertaking in terms of added costs,” he adds. “The auditors should be doing this anyway.”

Joseph Carcello, a professor at the University of Tennessee and co-author of the study that found 90% of fraud at public companies involved either the CEO or CFO, agrees.

“Auditors are already required to audit executive compensation plans,” Carcello says. “The intent is not to change compensation plans, but to consider how they might affect risk to the company.”

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